Valuations, quality of U.S. credit called into question by managers

The late credit cycle in the U.S. is presenting problems for money managers, with concerns rising over valuations and credit quality.

Executives echoed concerns raised by Gregoire Haenni, chief investment officer at the of the 12.8 billion Swiss franc ($12.79 billion) Caisse de Prevoyance de l'Etat de Geneve, Geneva, who said there has been a gradual decline in U.S. investment-grade bond index constituents in the past 10 years.

Adrian Grey, head of fixed income at Insight Investment in London, said it is interesting that investors are "starting to pick up on an erosion of quality — U.S. investment grade is relatively tight."

He said there is also a releveraging story in place. "The average rating on U.S. investment grade has gone from high single A to BBB over five or six years."

He said most buyers of U.S. credit are based in the U.S., but there is a marginal buyer issue. "We are of the view that … all the good drinks have been drunk, and while the party hasn't ended yet the smart money is sidling toward the door. We have gone from playing long (dollar credit) side to a much more neutral stance," allowing executives the flexibility to move over- or underweight. "That is across U.S. and euro credit. A much more defensive mindset is where we are at," he said.

Valuations are also adding to a less rosy picture for U.S. credit.

"The biggest feature we've been picking up the last year or so is dollar credit is becoming more expensive," said Jamie Hamilton, a global credit manager on the institutional public debt team at M&G Investments in London. "The last 10 years, particularly with sterling-denominated credit, dollar credit has offered a significant pickup."

But over the past six months to one year, that situation has changed, he said: "The dollar credit market has performed very well ... and that premium ... has disappeared. For us from a tactical point of view, the pull toward the dollar market has been much less strong."

He also highlighted the quality of corporates toward the end of a credit cycle, an issue "probably most keenly felt in the dollar market where the largest volume of issues is coming through. At this stage the concern is new issues are coming through that might not be as high quality as they might normally be."

On a general basis, Mr. Hamilton said the team is "getting a little concerned that the rating agencies are being very forgiving when it comes to some of the issues coming through," particularly where firms are involved in M&A deals and building up leverage — but still retaining their credit ratings. Increased leverage, and extending that leverage out to longer maturities than previously, "leads to potentially concerns about whether companies are just being given too much rope by the agencies," he said. While it's not an issue specific to the U.S. market, it is felt most there because of the volume of issuance.

Elsewhere, BNP Paribas Asset Management remains overweight credit, but leaning toward Europe over the U.S. because, on a relative basis "it is safe to say credit conditions are arguably less attractive in the U.S. than Europe as (the U.S.) is late in the cycle," said Daniel Morris, senior investment strategist in London.

And executives at Amundi also have scaled back U.S. credit allocations in the past few months, beginning with high yield and then investment grade, "because of the issues of valuation," said Vincent Mortier, deputy chief investment officer in Paris. "It has been done gradually, but constantly."